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Case 26-2

Forner Carpet Company produces carpets for automobiles. It raised the price of its carpet L-42 from $3.95 to $4.75 per square yard in 1993 in order to increase margins. However, this resulted in lost market share to competitors who held their price at $3.95. Forner's marketing manager estimates Forner could sell 150,000 yards of L-42 at $3.95 but only 75,000 yards at $4.75. The manager and chief accountant are deciding whether to lower the price back to $3.95 for the first half of 1994.

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557 views3 pages

Case 26-2

Forner Carpet Company produces carpets for automobiles. It raised the price of its carpet L-42 from $3.95 to $4.75 per square yard in 1993 in order to increase margins. However, this resulted in lost market share to competitors who held their price at $3.95. Forner's marketing manager estimates Forner could sell 150,000 yards of L-42 at $3.95 but only 75,000 yards at $4.75. The manager and chief accountant are deciding whether to lower the price back to $3.95 for the first half of 1994.

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Nisha
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Case 26-2

Forner Carpet Company*


Forner Carpet Company produced high-grade high-grade carpeting materials for use in automobiles and
recreational vans. Forner’s products were sold to finishers, who cut and boud the materials so that it
would fit perfectly in the passenger’s compartment or cargo area (e.g., automobile trunk) of a specific
model vehicle. These finishers also made carpet floor mats. Some of these finishers were captive
operations of major automobile assembly divisions, particularly those that assembled the “top of the
line” cars that included high-grade carpeting; other finishers concentrated on the replacement and van
customizing markets.

Late in 1993, the marketing manager and the chief accountant of Forner met to decide on the list price
for the carpet number L-42. It was industry practice to announce prices just prior to the January-June
and July-December “seasons.” Over the years, companies in the industry had adhered to their
announced prices throughout a six-month season unless significant unexpected changes in costs
occurred.

Forner was the largest company in its segment of the automobile carpet industry; its 1993 sales had
been over $40 million. Forner’s salespersons were on a salary basis, and each one sold the entire
product line. Most of the Forner’s competitors were smaller than Forner; accordingly, they usually
awaited Forner’s price announcement before setting their own selling prices.

Carpet L-42 had an especially dense nap; a result, making it required a special machine, and it was
produced in a department whose equipment could not be used to produce Forner’s other carpets.
Effective January 1, 1993, Forner had raised its price on this carpet from $3.95 to $4.75 per square yard.
This had been done in order to bring L-42’s margin up to that of other carpet on the line. Although
Forner was financial sound, it expected a large funds need in the next few years for equipment
replacement and possible diversification. The 1993 price increase was one of several decisions made in
order to provide funds for these plans.

Forner’s competitors, however, had held their 1993 prices at $3.95 on carpet competitive with L-42. As
shown in Exhibit 1, which includes estimates of industry volume on these carpets, Forner’s price
increase had apparently resulted in loss of market share. The marketing manager, Kim Gurskis,
estimated that the industry would sell about 630,000 square yards of these carpets in the first half of
1994. Gurskis was sure Foner could sell 150,000 yards if it dropped the price of L-42 back to $3.95. But if
Forner held its price at $4.75, Gurskis feared further erosion in Forner’s share. However, because some
customers felt that L-42 was superior to competitive products, Gurskis felt that Forner could sell at least
75,000 yards at the $4.75 price.
During their discussion, Gurskis and the chief account, Brooks Coleman, identified two other aspects of
the pricing decision. Coleman wondered whether competitors would announce a further price decrease
if Forner dropped back to $3.95. Gurskis felt it was unlikely that competitors would price below $3.95

EXHIBIT 1 Carpet L-42: Prices and Production, 1991-1993


Production Volume Price
(square yards) (per square yard)
Selling Industry Forner Most Former
Season* Total Carpet Competitors Carpet
1991-1 549,000 192,000 $4.75 $4.75
1991-2 517,500 181,000 4.75 4.75
1992-1 387,000 135,500 3.95 3.95
1992-2 427,500 149,500 3.95 3.95
1993-1 450,000 135,000 3.95 4.75
1993-2 562,500 112,500 3.95 4.75
*199x-1 means thwe first 6 months of 199x; 199x-2 means the second 6 months of 199x.

EXHIBIT 2 Estimated Cost per Square Yard of Carpet L-42 at Various Production Volumes
First Six Months of 1994

  Volume (square yards)


  $0,000 75,000 100,000 125,000 150,000 175,000
Raw materials $0.520 $0.520 $0.520 $0.520 $0.520 $0.520
Market spoilage 0.052 0.051 0.049 0.049 0.051 0.052
Direct labor 1.026 0.989 0.979 0.962 0.957 0.997
Department overhead:
Direct* 0.568 0.544 0.524 0.52 0.52 0.52
Indirect† 1.24 0.827 0.62 0.496 0.413 0.354
General overhead‡ 0.308 0.297 0.294 0.289 0.293 0.299
Factory cost 3.714 3.228 2.986 2.826 2.772 2.742
Selling and administrative§ 1.671 1.453 1.344 1.276 1.247 1.234
Total cost $5.385 $4.681 $4.330 $4.112 $4.019 $3.976

*Materials handelers, supplies, repairs, power, fringe benefits

†Supervision, equipment depreciation

‡30 percent of direct labour.

§45 percent of factory cost.


because none of them was more efficient than Forner, and there was rumors that several of them were
in poor financial condition. Coleman’s other concern was whether a decision relating to carpet L-42
would have any impact on the sales of Forner’s other carpets. Gurskis was convinced that since L-42 was
a specialized item, there was no interdependence between its sales and those of other carpets in the
line.

Exhibit 2 contains cost estimates that Coleman had prepared for various volumes of L-42. These
estimates represented Coleman’s best guesses as to costs during the first six months of 1994, based on
past cost experience and anticipated inflation.

Questions
1. What was the relationship (if any) between the L-42 pricing decision and the company’s future
need for capital funds?
2. Assuming no other prices are to be considered, should Forner price L-42 at $3.95 or $4.75?
3. If Forner’s competitors hold their prices at $3.95, how many square yards of L-42 would Forner
need to sell at a price of $4.75 in order to earn the same profit as selling 150,000 square yards at
a price of $3.95?
4. What additional information would you wish to have before making this pricing decision?
(Despite the absence of this information, still answer question 2)
5. With hindsight, was the decision to raise the price in 1993 a good one?

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